The Tax Court in Brief May 25 – 29, 2020

The Tax Court in Brief May 25 – 29, 2020

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.

The Week of May 25 – 29, 2020

• Gluck v. Comm’r, T.C. Memo. 2020-66
• Amanda Iris Gluck Irrevocable Trust v. Comm’r, T.C. Memo. 154 T.C. No. 11 
• Thoma v. Comm’r, T.C. Memo. 2020-67 
• Novoselsky v. Comm’r, T.C. Memo. 2020-68 
• Engle v. Comm’r, T.C. Memo. 2020-69
• Larkin v. Comm’r, T.C. Memo. 2020-70

Gluck v. Comm’r, T.C. Memo. 2020-66

May 19, 2020 | Lauber, J. | Dkt. No. 2020-66

• Opinion

Short Summary:  The IRS determined that the petitioners were not permitted to defer capital gain as part of a like-kind exchange and asserted a tax deficiency and penalties, prompting the taxpayers to file a petition with the Tax Court.  The IRS moved to dismiss the case for lack of jurisdiction with respect to the tax deficiency.  The taxpayers, in turn, moved for summary judgment, arguing that they were substantively entitled to like-kind exchange treatment under section 1031.

On June 30, 2012, the taxpayer sold a condominium unit for $10,214,000.  He deposited the proceeds from the sale of the condominium unit into a “qualified escrow account.”  See sec. 1.1031(k)-1(g)(3).  The taxpayer designated as the “replacement property” a purported 25% interest in an apartment building. The IRS, however, determined that the replacement property that the taxpayer acquired was in fact an interest in a partnership, rather than a direct interest in the real estate.  The partnership was subject to the unified audit and litigation procedures of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). See secs. 6221- 6234 (as in effect for years before 2018).

The taxpayer did not report the property in a manner consistent with the reporting that the IRS received from the partnership, Greenberg & Portnoy (G&P).  G&P’s returns reported that it owned the Property and that Gluck LLC (an entity established by the taxpayer) in 2012 acquired a partnership interest in G&P, as opposed to a direct ownership interest in the apartment building.

Although the taxpayer acknowledged receipt of a Schedule K-1 reporting as such, he did not report the distributive share of G&P’s income on their 2012 Form 1040. Nor did he file with the IRS Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR). (Taxpayers are instructed to file Form 8082 if they “believe an item was not properly reported on the Schedule K-1 you received from the partnership.” IRS, Instructions for Form 8082, at 1 (rev. Dec. 2011).)

The IRS argued that its adjustment disallowing like-kind exchange treatment was necessary to conform the taxpayer’s tax treatment to the treatment shown on the partnership’s return and was thus a “computational adjustment” within the meaning of section 6231(a)(6).

Key Issue:  Whether the Tax Court has jurisdiction to address the deficiency resulting from the IRS’s adjustments, denying section 1031 treatment on the ground that the taxpayer did not comply with section 1031 because the taxpayer’s “replacement property” was actually an interest in a partnership, which is not “like-kind” property.

Primary Holdings: 

• The Tax Court lacks jurisdiction to redetermine the deficiency but has jurisdiction with respect to the penalty.
• Whether G&P was a valid partnership, whether Gluck LLC was a partner in G&P, and what percentage interest Gluck LLC held in G&P are all “partnership items.” The question of G&P’s ownership vel non of the building is a “partnership item.” Such “partnership items” must be determined in a partnership-level proceeding, as opposed to a deficiency case. The Tax Court has no jurisdiction to consider partnership items in a partner-level deficiency proceeding.
• Although petitioners dispute the true ownership of the Property and Gluck LLC’s status as a partner, the Tax Court has no jurisdiction to consider such partnership items in a deficiency case.
• Because Gluck LLC’s interest in G&P was a partnership item, the IRS’ disallowance of deferral under section 1031 was a change in petitioners’ tax liability that properly reflected G&P’s treatment of a partnership item.
• Petitioners’ entitlement to section 1031 treatment is not a “factual affected item” but rather is a “computational affected item” exempt from deficiency procedures. “If an adjustment to an affected item * * * can be made without making additional partner level determinations, the IRS can directly assess the tax due without having to follow the usual deficiency procedures.”
• The accuracy-related penalty, however, is within the Tax Court’s deficiency jurisdiction. Liability for the penalty is not a “computational affected item,” because the taxpayer’s liability hinges on factual determinations peculiar to them, e.g., their good-faith effort to determine their Federal income tax liability correctly, including any honest misunderstanding of fact or law. See id. at 377; sec. 1.6664-4, Income Tax Regs; sec. 301.6231(a)(6)-1(a)(3), Proced. & Admin. Regs.

Key Points of Law:

• The 2012 version of the Tax Code provided that like-kind exchange treatment does not apply “to any exchange of * * * interests in a partnership.” Sec. 1031(a)(2)(D).
• Deficiency procedures generally do not apply “to the assessment or collection of any computational adjustment.” Sec. 6230(a)(1).
• The Tax Court is a court of limited jurisdiction, and may exercise jurisdiction only to the extent expressly authorized by Congress.
• The Tax Court normally has jurisdiction to redetermine a deficiency if a taxpayer receives a notice of deficiency and timely petitions the Court.
• The Code restricts deficiency jurisdiction in several respects where a TEFRA partnership is concerned.
• The provisions of chapter 63, subchapter B, which govern deficiency jurisdiction, generally do not apply “to the assessment or collection of any computational adjustment” made with respect to a partner in a TEFRA partnership. Sec. 6230(a)(1).
• Section 6231(a)(6) defines a computational adjustment as “the change in the tax liability of a partner which properly reflects the treatment under * * * [TEFRA] of a partnership item.”
• The proper treatment of “partnership items” (as well as penalties and additions to tax relating to adjustments to partnership items) is determined in a TEFRA partnership-level proceeding. The proper treatment of “affected items which require partner level determinations” is generally determined in deficiency proceedings involving the relevant partner(s). Sec. 6230(a)(2)(A)(i); see sec. 301.6231(a)(6)-1(a)(3), Proced. & Admin. Regs. However, “[i]f an adjustment to an affected item is merely computational and can be made without making additional partner-level determinations, the IRS can directly assess the tax due without having to follow the usual deficiency procedures.”  See sec. 301.6231(a)(6)-1(a)(2), Proced. & Admin. Regs.
• A partnership item is “any item required to be taken into account for the partnership’s taxable year * * * to the extent regulations prescribed by the Secretary provide that * * * such item is more appropriately determined at the partnership level than at the partner level.” Sec. 6231(a)(3)
• Whether a person is a partner in a partnership is generally a “partnership item.”
• The existence of a valid partnership is itself a “partnership item.” Tigers Eye Trading, LLC v. Commissioner, 138 T.C. 67, 98- 99 (2012), aff’d in part, rev’d in part, and remanded sub nom. Logan Trust v. Commissioner, 616 F. App’x 426 (D.C. Cir. 2015).
• The term “partnership item” includes “the legal and factual determinations that underlie the determination of the amount, timing, and characterization of items of income, credit, gain, loss, deduction, etc.” Sec. 301.6231(a)(3)-1(b), Proced. & Admin. Regs.
• Section 6225(a) generally prohibits the IRS from assessing “a deficiency attributable to any partnership item” until TEFRA partnership-level proceedings have concluded. However, if a partner who adopts an inconsistent treatment fails to notify the IRS as required by section 6222(b), “section 6225 shall not apply to any part of a deficiency attributable to any computational adjustment required to make the treatment * * * by such partner consistent with the treatment of the items on the partnership return.” Sec. 6222(c).
• The Code denies like-kind exchange treatment where a real property interest is exchanged for a partnership interest. See sec. 1031(a)(2)(D).
• The provisions governing this Court’s deficiency jurisdiction generally do not apply “to the assessment or collection of any computational adjustment.” Sec. 6230(a)(1). The only exception to this rule (as relevant here) arises in the case of a “deficiency attributable to * * * affected items which require partner level determinations.” Id. para. (2)(A)(i).
• Petitioners’ entitlement to like-kind exchange treatment is properly viewed as an “affected item” because it is “affected by a partnership item.” Sec. 6231(a)(5).
• An affected item may be a “computational affected item” or a “factual affected item.” Computational affected items (e.g., a partner’s medical expense deduction) can be determined automatically once the relevant partnership item (e.g., that partner’s distributive share of partnership income) has been determined. See, e.g., Bedrosian v. Commissioner, 144 T.C. 152, 158 (2015). A factual affected item is one that “requires further factual determination at the partner level.”
• “Computational affected items are not subject to deficiency procedures,” whereas “affected items that require partner level factual determinations are subject to deficiency procedures.”
• Deficiency procedures do not apply to “penalties, additions to tax, and additional amounts that relate to adjustments to partnership items.” Sec. 6230(a)(2)(A)(i). Penalties determined under section 6662(a), however, are non-partnership items. As a rule, therefore, such penalties are subject to deficiency proceedings unless they are “computational affected items.”

Insight:  Good riddance to TEFRA.  So much judicial ink has been spilled fleshing out the sometimes-metaphysical nuances of this procedural regime that has been on the books since 1982.  With the enactment of the Bipartisan Budget Act of 2015, a new regime (the “BBA”) governing partnership audits and litigation generally went into effect in 2018.  While we will continue to see TEFRA litigation making its way through the system for the better part of a decade, partnership tax disputes will now be subject to a new regime.

Amanda Iris Gluck Irrevocable Trust v. Comm’r, T.C. Memo. 154 T.C. No. 11 

May 26, 2020 | Lauber, J. | Dkt. No. 5760-19L

• Opinion

Short Summary:   The case involved a collection due process (CDP) proceeding under which the taxpayer sought review pursuant to section 6330(d)(1) of a determination by the Internal Revenue Service (IRS or respondent) to sustain collection action for tax years 2013, 2014, and 2015.

The taxpayer was a direct and indirect partner in partnerships subject to the unified audit and litigation procedures of the Tax Equity and Fiscal Responsibility Act of 1982. See I.R.C. secs. 6221-6234 (as in effect for years before 2018). In 2012 one of the partnerships in which the taxpayer held an indirect interest sold property and realized a large capital gain.  The taxpayer allegedly failed to report its entire distributive share of that gain.

For 2012, the taxpayer filed a return on Form 1041, U.S. Income Tax Return for Estates and Trusts. On this return it allegedly failed to report its distributive share of the gain that had been allocated to a partnership holding.

The IRS adjusted the taxpayer’s 2012-2015 returns via “computational adjustments.” See I.R.C. sec. 6231(a)(6). These adjustments eliminated the net operating loss (NOL) it had claimed for 2012 and disallowed the NOL carryforward deductions the taxpayer had claimed for 2013-2015, creating balances due for those years. The IRS immediately assessed the resulting tax. See I.R.C. secs. 6222(c), 6230(a)(1).

On June 15, 2017, the IRS sent the taxpayer two Letters 4735, Notice of Computational Adjustment. In the first letter the IRS adjusted upward, by $6,543,748, the taxpayer’s distributive share of the partnership’s capital gain for 2012, eliminating the NOL that the taxpayer had reported for that year. In the second letter the IRS disallowed the NOL carryforwards from 2012 that the taxpayer had claimed as deductions for 2013, 2014, and 2015, creating a balance due for each year. Each Letter 4735 explained that “[t]he adjustment is due to your inconsistent treatment of a partnership item related to the section 1231 gain reported by a partnership in which you have an indirect ownership.”

Subsequently, the IRS mailed a levy notice in an effort to collect the taxpayers 2013-2015 tax, and the taxpayer timely requested a collection due process (CDP) hearing. The settlement officer sustained the levy notice. The taxpayer timely petitioned for review, seeking to challenge its underlying liabilities for 2012-2015. The IRS moved to dismiss as to 2012 and 2013, noting that the 2012 tax year was never before the Court and that the taxpayer’s 2013 liability had been fully satisfied by application of credits from other years. The IRS moved for summary judgment as to 2014 and 2015.

The IRS thereafter assessed petitioner’s liabilities for 2013-2015. When the taxpayer did not pay these liabilities upon notice and demand, the IRS issued, on January 11, 2018, a Letter 1058, Final Notice of Intent to Levy and Notice of Your Right to a Hearing (levy notice). As of the date of the levy notice, the taxpayer’s outstanding liabilities for 2013-2015 exceeded $180,000.

Key Issue:  Whether the Tax Court had jurisdiction to review the taxpayer’s tax liability through a CDP challenge.

Primary Holdings: 

• The Court lacks jurisdiction with respect to the taxpayer’s 2012 tax year.
• The taxpayer properly invoked the Court’s jurisdiction under I.R.C. sec. 6330(d)(1) to review its tax liabilities for 2013- 2015. Although the Court generally lacks jurisdiction in a deficiency case to review computational adjustments, see I.R.C. sec. 6230(a)(1), its jurisdiction in a CDP case is not so limited.
• The taxpayer’s 2013 liability has been paid in full, so the taxpayer’s challenge to the collection action for that year is moot.
• The Tax Court may, in a CDP case, review underlying liabilities arising from adjustments to partnership items of TEFRA partnerships, even though such items would not have been subject to review in a deficiency setting.
• The taxpayer is permitted to challenge its underlying liabilities for 2014 and 2015 because it had had no prior opportunity to do so. See I.R.C. sec. 6330(c)(2)(B). The taxpayer properly raised an underlying liability challenge during the CDP hearing by contending that the IRS had improperly disallowed its NOL carryforward deductions for 2014 and 2015. Because genuine disputes of material fact exist as to the taxpayer’s correct tax liabilities for those years, the IRS’s motion for summary judgment will be denied.

Key Points of Law:

• Section 6330(a) requires the IRS, before making a levy, to send a written notice to the taxpayer notifying him of his right to a CDP hearing. The Tax Court has jurisdiction to review a notice of determination issued to a taxpayer following completion of that hearing if a timely petition is filed. Sec. 6330(d).
• Section 6330(d)(1) does not prescribe the standard of review that the Court should apply in reviewing an IRS administrative determination in a CDP case. But its case law provides that where the taxpayer’s underlying tax liability is properly before the court, it reviews the SO’s determination de novo. Goza v. Commissioner, 114 T.C. 176, 181-182 (2000). In other respects, the court reviews the IRS action for abuse of discretion. Abuse of discretion exists when a determination is “arbitrary, capricious, or without sound basis in fact or law.”
• A taxpayer may challenge the existence or amount of its underlying liability in a CDP proceeding only if it “did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability.” Sec. 6330(c)(2)(B).
• In CDP cases involving assessable penalties (viz., penalties not subject to deficiency procedures), the court has jurisdiction to review a taxpayer’s underlying liability for the penalty provided that he raised during the CDP hearing a proper challenge thereto.
• A taxpayer entitled to dispute its underlying liability must nevertheless present a proper challenge before the SO in order to preserve that challenge for judicial review.
• The Court may determine the correct amount of net operating loss for a year not in issue as a preliminary step in determining the correct amount of a net operating loss carryover to a taxable year in issue.
• In determining the allowability of an NOL carryforward or carryback deduction, the Court may consider facts from the original loss year even though the period of limitations for that year is closed.

Insight:  Where deficiencies result from a partnership proceeding or adjustment, an affected taxpayer needs to carefully vet their procedural avenues where that partnership is subject to the TEFRA statutory regime.  A taxpayer should also take precautions to preserve challenges to substantive tax liabilities in CDP hearings in order to utilize a more favorable standard of review on petition to the Tax Court.

Thoma v. Comm’r, T.C. Memo. 2020-67 

May 27, 2020 | Morrison, J. | Dkt. No. 21922-15

• Opinion

Short Summary:  On October 1, 1976, Mr. Thoma purchased a partial ownership interest in an accounting firm for $40,000. He worked as an accountant at the accounting firm. At some point after that, but before August 2005, Mr. Thoma became the sole owner of the accounting firm, and he began operating the firm as a sole proprietorship under the name “Thoma & Associates, CPAs”.

Around January 1, 2006, Mr. Thoma went into business with Eric Hjerpe, another accountant. Their accounting business appears to have absorbed Mr. Thoma’s sole proprietorship. Their business also appears to have initially operated under the name of Mr. Thoma’s former sole proprietorship, Thoma & Associates, CPAs, but by 2007, it was operating under the name Thoma & Hjerpe, CPAs.  During the period at issue, it was disputed whether the taxpayer (Mr. Thoma) was a partner of the firm or an employee.

Around November 3, 2011, the U.S. Department of Justice sent a letter to Thoma & Hjerpe. At trial Mr. Thoma described the letter as a civil investigative demand, issued personally to him, that requested the records of one or more of his clients. Mr. Thoma responded to the letter but never informed Mr. Hjerpe about it. Mr. Hjerpe eventually learned about the letter. A few weeks later, on November 20, 2011, Mr. Thoma arrived at the offices of Thoma & Hjerpe and found that the locks had been changed. He also discovered he no longer had access to the network, client files, and email accounts. That same day Mr. Thoma received a letter from Mr. Hjerpe informing him that he was being placed on administrative leave for his “gross mishandling” of the U.S. Department of Justice letter and asking him to “refrain from contacting any of our clients” until Mr. Hjerpe had “a better handle on what is going on”. Mr. Thoma did not provide any accounting services to his clients at Thoma & Hjerpe after receiving Mr. Hjerpe’s letter. His professional and business association with Thoma & Hjerpe ended on November 20, 2011, the day Mr. Hjerpe placed him on administrative leave.

On their tax returns for 2010 and 2011 Mr. and Ms. Thoma took the position that Mr. Thoma was self-employed and that the biweekly payments constituted self-employment income for each year, such that Mr. Thoma was liable for self-employment tax. They also claimed an income-tax deduction for one-half of the self-employment tax they reported for Mr. Thoma for each year. The IRS’s notice of deficiency determined that Mr. Thoma was not self employed, but rather an employee. The notice of deficiency recharacterized the reported self-employment income as wages.

Self-employed business-expense deductions. On their tax returns for 2010 and 2011 Mr. and Ms. Thoma claimed deductions of $7,396 and $20,867, respectively, for business expenses Mr. Thoma paid in rendering accounting services for Thoma & Hjerpe. They reported these deductions as affecting adjusted gross income (“AGI”), which is consistent with the deductions being categorized under section 62(a)(1) as attributable to a taxpayer’s business other than the business of providing services as an employee. The notice of deficiency determined that Mr. Thoma was an employee of Thoma & Hjerpe in 2010 and 2011, such that the expenses were not governed by section 62(a)(1) and not deductible in arriving at AGI. The notice of deficiency determined that Mr. Thoma’s expenses of working for Thoma & Hjerpe were deductible only as unreimbursed-employee-business expenses under section 67(b). That deduction is a subset of the miscellaneous itemized deductions allowed under section 67(b). Under section 67(a), total miscellaneous itemized deductions are allowed only to the extent they exceed 2% of AGI.

Self-employed health insurance expense deductions. On their tax returns for 2010 and 2011 Mr. and Ms. Thoma claimed self-employed health insurance expense deductions under section 162(l). Section 162(l) allows self-employed taxpayers a deduction for the cost of “insurance which constitutes medical care”, i.e., the cost of health insurance. Mr. and Ms. Thoma reported that Mr. Thoma paid health insurance expenses of $4,648 for 2010 and $5,580 for 2011. The notice of deficiency determined that Mr. Thoma was an employee of Thoma & Hjerpe and that the health insurance expenses were not properly deductible under section 162(l), but only as deductions for medical expenses under section 213(a). Section 213(a) allows a deduction for medical expenses, including health insurance expenses, but subject to a 7.5% of AGI floor.

Self-employed SIMPLE IRA contribution deductions. Mr. Thoma directly contributed $15,711 to his SIMPLE IRA in 2010 and $14,000 in 2011. Mr. and Ms. Thoma claimed deductions for those contributions. The notice of deficiency determined that the contributions were not deductible because Mr. Thoma was an employee of Thoma & Hjerpe.

Recovery of basis and character of 2011 installment sale payments. In 2008 Mr. Thoma sold his interest in Thoma & Hjerpe to Mr. Hjerpe. In 2011 he received installment sale payments from Mr. Hjerpe totaling $160,000. On their 2011 tax return Mr. and Ms. Thoma reported that the $160,000 installment sale payments were composed of $131,637 in long-term capital gain, $3,921 in taxable interest, and $24,442 in tax-free recovery of basis. The notice of deficiency determined that the installment sale payments were instead composed of $134,001 in long-term capital gain, $19,700 in taxable interest, and $6,299 in tax-free recovery of basis.

Accuracy-related penalties. The notice of deficiency determined that Mr. and Ms. Thoma were liable for accuracy-related penalties under section 6662(a) for 2010 and 2011.

Key Issue:  Whether the taxpayer was an employee or self-employed.

Primary Holdings: 

• Thoma was an employee. The court therefore sustains the self-employment tax and one-half of self-employment tax deduction adjustments in the notice of deficiency.
• The court sustains the determination that the business expenses are deductible only as unreimbursed-employee-business expenses
• The court sustains the determination regarding the tax treatment of Mr. Thoma’s health insurance expenses.
• The court sustains the determination that Mr. Thoma was an employee and sustains the disallowance of the SIMPLE IRA contribution deductions.
• The court sustains the determination regarding the recovery of basis and character of the 2011 installment sale payments.
• The court sustains penalties.

Key Points of Law:

• The taxpayer generally bears the burden of proving that the determinations in the notice of deficiency are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
• The burden of proof is satisfied by a preponderance of the evidence.
• If the taxpayer shows that the requirements of section 7491(a)(1) and (2) are satisfied for a particular factual issue, then the burden of proof is imposed on the IRS as to that issue. Higbee v. Commissioner, 116 T.C. 438, 442 (2001).
• Gross income is defined as all income from whatever source derived. Sec. 61(a).
• Taxpayers are subject to self-employment tax on their self-employment income during a taxable year, sec. 1401(a), (b)(2), and are allowed to deduct as an above-the-line income-tax deduction (i.e., a deduction in arriving at AGI) an amount equal to one-half of the self-employment tax, sec. 164(f). Self-employment income is generally defined as “the net earnings from self employment derived by an individual”. Sec. 1402(b). “Net earnings from self-employment” are defined as “the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business.” Sec. 1402(a). The term “trade or business”, for purposes of the definition of net earnings from self-employment, has the same meaning as when used in section 162, except that the performance of services by an individual as an employee is not included in the term “trade or business”. Sec. 1402(c)(2). The term “employee” for purposes of self-employment tax has the same meaning as under the Federal Insurance Contributions Act. Sec. 1402(d). Under the Federal Insurance Contributions Act, an “employee” (as relevant here) is “any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee”. Sec. 3121(d)(2).
• An individual who is a limited partner generally excludes from net earnings from self-employment his or her share of partnership income or loss, with the exception of guaranteed payments for services actually rendered to or on behalf of the partnership to the extent that the guaranteed payments are established to be in the nature of remuneration for those services. Sec. 1402(a)(13).
• Section 761(b) defines a “partner” as a member of a partnership. Section 761(a) defines a “partnership” as a “syndicate, group, pool, joint venture, or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not * * * a corporation or a trust or estate.”
• Federal law controls the question of whether an entity is classified as a partnership for federal tax purposes. Luna v. Commissioner, 42 T.C. 1067, 1077 (1964).
• A bona fide partnership exists under the Code if the putative partners “really and truly intended to join together for the purpose of carrying on business and sharing in the profits or losses or both.” Commissioner v. Tower, 327 U.S. 280, 287 (1946). The following factors are relevant in evaluating whether the putative partners intended to create a partnership for federal-income-tax purposes:
  • [1] The agreement of the parties and their conduct in executing its terms; [2] the contributions, if any, which each party has made to the venture; [3] the parties’ control over income and capital and the right of each to make withdrawals; [4] whether each party was a principal and coproprietor, sharing a mutual proprietary interest in the net profits and having an obligation to share losses, or whether one party was the agent or employee of the other, receiving for his services contingent compensation in the form of a percentage of income; [5] whether business was conducted in the joint names of the parties; [6] whether the parties filed Federal partnership returns or otherwise represented to respondent [i.e., the IRS] or to persons with whom they dealt that they were joint venturers; [7] whether separate books of account were maintained for the venture; and [8] whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise.
• The Court applies common law rules to determine whether a worker is an employee under section 1402(d). See sec. 3121(d)(2); Prof’l & Exec. Leasing, Inc. v. Commissioner, 89 T.C. 225, 231 (1987), aff’d, 862 F.2d 751 (9th Cir. 1988); Simpson v. Commissioner, 64 T.C. at 984. Whether a worker is an employee is a factual question. Weber v. Commissioner, 103 T.C. 378, 386 (1994), aff’d per curiam, 60 F.3d 1104 (4th Cir. 1995). The court generally considers several factors in making this determination: (1) whether the relationship between the worker and the one to whom the worker provides services (i.e., the principal) was permanent; (2) whether the worker had an opportunity for profit or loss; (3) whether the principal had the right to discharge the worker; (4) whether the principal or the worker invested in the facilities the worker used; (5) whether the work was part of the principal’s regular business; (6) whether the principal could exercise control over the details of the work; and (7) whether the worker and the principal believed that they were creating an employment relationship. Id. at 387. No one factor is determinative; the court looks at all relevant facts. Id.
• In general, the term “installment sale” means “a disposition of property where at least 1 payment is to be received after the close of the taxable year in which the disposition occurs.” Sec. 453(b)(1). “[I]ncome from an installment sale shall be taken into account for purposes of this title under the installment method.” Sec. 453(a). The term “installment method” means “a method under which the income recognized for any taxable year from a disposition is that proportion of the payments received in that year which the gross profit (realized or to be realized when payment is completed) bears to the total contract price.” Sec. 453(c). The gross profit is equal to the contract price less adjusted basis. Sec. 15A.453-1(b)(2)(v), Temporary Income Tax Regs., 46 Fed. Reg. 10710 (Feb. 4, 1981). Interest is not part of the gross profit, and it is excluded from the selling price, the contract price, and the installment sale payment. Id. subdiv. (ii), 46 Fed. Reg. 10709. The gross profit (realized or to be realized when payment is completed) divided by the total contract price is also referred to as the gross profit percentage. The income for the year is equal to the payments received in that year multiplied by the gross profit percentage. Sec. 453(c); sec. 15A.453-1(b)(2)(i), Temporary Income Tax Regs., supra.
• Section 6662(a) imposes a 20% penalty on the portion of an underpayment of tax that is attributable to negligence, or to a substantial understatement of income tax, or to various other causes. Sec. 6662(b).
• Negligence includes any failure to make a reasonable attempt to comply with the tax laws. Sec. 6662(c); sec. 1.6662-3(b), Income Tax Regs. Negligence is strongly indicated where a taxpayer fails to make a reasonable attempt to determine the correctness of a deduction, credit, or exclusion that would seem to a reasonable person to be “too good to be true”. Sec. 1.6662-3(b)(1)(ii), Income Tax Regs. Negligence also includes a failure to maintain accurate records or to substantiate items properly. Sec. 1.6662-3(b)(1), Income Tax Regs. An understatement is substantial if it exceeds the greater of “(i) 10 percent of the tax required to be shown on the return for the taxable year, or (ii) $5,000.” Sec. 6662(d)(1)(A)
• A SIMPLE IRA plan is a small-employer-sponsored individual retirement plan that is funded by employee compensation deferrals and employer matching contributions.8 See sec. 408(p)(1) and (2).

Insight:  The case was a complete loss for the taxpayers.  In 104 pages of IRS-deferential findings, the court sifted through a convoluted business relationship and unique factual setting to determine whether the taxpayer was a partner or an employee of the business.  The case demonstrates the multi-factor test for determining partnership status, and underscores that such an analysis is a matter of federal law (insofar as the question is, as here, whether a partnership exists for federal tax purposes).

Novoselsky v. Comm’r, T.C. Memo. 2020-68 

May 28, 2020 | Lauber, J. | Dkt. No. 22400-13

• Opinion

Short Summary: During 2009 through 2011, Mr. Novoselsky, an attorney, practiced law with a focus on class action litigation.  In those years, he executed “litigation support agreements” with various individuals and entities.  Under those agreements, the individuals and entities made upfront payments to support the costs of litigation.  If the litigation was successful, Mr. Novoselsky was obligated to pay the counter-party, from his award of attorney’s fees and costs, the initial payment advanced to Mr. Novoselsky plus a premium.  However, if the litigation was not successful, Mr. Novoselsky had no obligation to return any funds to the counter-party.

Mr. Novoselsky and his wife filed joint returns with a Schedule C, Profit or Loss From Business, to report the business activities of Mr. Novoselsky’s law firm.  On the Schedule C, Mr. Novoselsky did not report any of the funds advanced to him pursuant to the litigation support agreements in which he had no obligation to repay the counter-party.  The IRS examined the returns and issued a notice of deficiency to Mr. and Mrs. Novoselsky.  In the notice of deficiency, the IRS determined that the advanced funds for which there was no repayment obligation should be reported as gross income to Mr. Novoselsky.  In addition, the IRS asserted accuracy-related penalties with respect to these items.

Key Issue:  Whether the funds advanced to Mr. Novoselsky constitute a loan or gross income and whether Mr. and Mrs. Novoselsky are liable for accuracy-related penalties.

Primary Holdings:

• The payments Mr. Novoselsky received from third parties constituted gross income to Mr. Novoselsky and not loans. Specifically, the payments were not loans because any obligation for Mr. Novoselsky to repay was contingent on future events and therefore did not constitute valid debt for federal income tax purposes.
• In addition, the payments under the litigation agreements do not represent bona fide loans under factors used by federal courts to distinguish between debt and other payments because: (1) Mr. Novoselsky did not execute a formal promissory note; (2) no fixed schedule for repayments was established; (3) Mr. Novoselsky provided no collateral or security; and (4) no payments of principal or interest were ever made.
• Mr. and Mrs. Novoselsky are liable for accuracy-related penalties because: (1) they have put forth no evidence showing reasonable cause; and (2) Mr. Novoselsky is an attorney who had knowledge and education required to determine his tax obligations correctly.  

Key Points of Law:

• The Commissioner’s determination of tax liability is generally presumed correct. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).  In order for this presumption to attach in unreported income cases, the IRS must show a “rational foundation” for the IRS’ determination that the taxpayer received such income.  Pittman v. Comm’r, 100 F.3d 1308, 1313 (7th Cir. 1996), aff’g, T.C. Memo. 1995-243.  Once the Commissioner makes the required threshold showing, the burden shifts to the taxpayer to prove by a preponderance of the evidence that the Commissioner’s determinations are arbitrary or erroneous.  Walquist v. Comm’r, 152 T.C. 61, 67-68 (2019).
• I. R.C. § 61(a) defines gross income as “all income from whatever source derived,” including income derived from business. If a taxpayer is a cash method taxpayer, the taxpayer must include cash sums received in the tax year unless the receipts are nontaxable.  Treas. Reg. § 1.451-1(a).
• Because a genuine loan is accompanied by an obligation to repay, loan proceeds do not constitute income to the taxpayer. Comm’r v. Tufts, 461 U.S. 300, 307 (1983).  For this rule to apply, however, the obligation to repay “must be unconditional and not contingent upon some future event.”  Frierdich v. Comm’r, 925 F.2d 180, 185 (7th Cir. 1991).  “Perhaps the most important underlying principle is that no valid debt exists unless there is an unconditional obligation of another to pay * * * a definite sum of money.”  Henderson, 375 F.2d at 39.
• Where an obligation to pay arises only upon the occurrence of a future event, the Tax Court has consistently held that a valid debt does not exist for federal tax purpose. Taylor v. Comm’r, 27 T.C. 361 (1956), aff’d, 258 F.2d 89 (2d Cir. 1958); Clark v. Comm’r, 18 T.C. 780, aff’d, 205 F.2d 353 (2d Cir. 1953).  The same analysis applies to payment obligations conditioned on the outcome of litigation.  See Bercaw v. Comm’r, 165 F.2d 521, 525 (4th Cir. 1948); Estate of Paine v. Comm’r, T.C. Memo. 1963-275.
• Courts have used a variety of tests to guide the determination of whether particular types of advances should be treated as “loans” for federal tax purposes. See Busch v. Comm’r, 728 F.2d 945, 948 (7th Cir. 1984), aff’gC. Memo. 1983-98; Ill. Tool Works Inc. Comm’r, T.C. Memo. 2018-121.
• A gift, for federal income tax purposes, is one made out of a “detached and disinterested generosity” or “out of affection, respect, admiration, charity or like impulses.” Comm’r v. Duberstein, 363 U.S. 278, 285 (1960).
• As a general rule, funds that a taxpayer receives in trust for another person are not includable in the taxpayer’s gross income. Canatella v. Comm’r, T.C. Memo. 2017-124.
• For individual taxpayers, the substantial understatement penalty applies if the understatement of income tax for a particular year “exceeds the greater of—(i) 10 percent of the tax required to be shown on the return * * *, or (ii) $5,000.” R.C. § 6662(d)(1)(A).  The section 6662 penalty does not apply to any portion of an underpayment “if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to * * * [it].”  I.R.C. § 6664(c)(1). The decision as to whether the taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances.  Treas. Reg. § 1.6664-4(b)(1).  Circumstances that may signal reasonable cause and good faith “include an honest misunderstanding of fact or law that is reasonable in light of all the facts and circumstances, including the experience, knowledge, and education of the taxpayer.  Id.

Insight:  The Novoselsky decision shows the breadth of I.R.C. § 61 and its statutory language that gross income includes all income from whatever source derived.  Because the taxpayer received advances from third parties in which there was no obligation to repay, the Tax Court determined the payments represented gross income.  Notably, if Mr. Novoselsky used the payments for deductible business expenses, he would be entitled to a deduction to offset the gross income, but the decision does not address this issue.

Engle v. Comm’r, T.C. Memo. 2020-69 

May 28, 2020 | Cohen, J. | Dkt. No. 15791-17L

• Opinion

Short Summary:  In 2004, the U.S. Attorney’s Office (USAO) filed an information in federal court charging Mr. Engle with a single count of violation I.R.C. § 7201 by attempting to evade or defeat tax for 1998.  Mr. Engle pled guilty to the information in 2004.

Later, the federal court sentenced Mr. Engle to four years of probation including 18 months of home detention.  The district court did not make a finding of the exact amount of the tax loss involved in the case and did not order full restitution in that amount.  Rather, the federal court ordered that the exact amount of restitution would be determined by the IRS.  Moreover, the federal court directed Mr. Engle pay $25,000 immediately to the IRS and $100,000 within 90 days of the sentence hearing.  On April 4, 2008, the federal court issued a written judgment that stated the exact amount of restitution would “be determined by the IRS.”

The USAO appealed the federal court’s decision, and on January 13, 2010, the Fourth Circuit Court of Appeals vacated the federal court’s decision and remanded the case for resentencing.  Specifically, the Fourth Circuit indicated that it was unable to determine whether Mr. Engle’s sentence was reasonable, particularly where the federal sentencing guidelines recommended a term of imprisonment.  In addition, the Fourth Circuit provided that the federal court was required to reconsider its refusal to order full restitution, particularly because of the significant benefits the Government would have with regard to collection and enforcement.

The federal court resentenced Mr. Engle to 60 months of incarceration and 14 months of supervised release.  The court also ordered him to make restitution to the IRS of $620,549.

On May 26, 2014, the IRS made restitution-based assessments against Mr. Engle for 1984, 1986-1993, and 1995-2001, which totaled the restitution ordered by the federal court in its 2011 amended judgment.  That same day, the IRS mailed Mr. Engle a notice and demand for payment and thereafter issued a notice of federal tax lien.  Mr. Engle filed for a Collection Due Process (CDP) hearing challenging the amount of the restitution-based assessments.  The IRS issued a Notice of Determination to sustain the notice of tax lien filing, concluding:  (1) a taxpayer cannot challenge the amount of court-ordered restitution in a CDP hearing; (2) because the Court of Appeals vacated the federal court’s sentencing order the 2008 restitution order was rendered void, meaning the ultimate restitution order was the amended 2011 judgment; (3) interest was properly assessed on the restitution-based assessments; (4) a lien withdrawal was not appropriate; and (5) the proper legal and procedural requirements had been met in the assessment and collection of the restitution.

Key Issue:  Whether the IRS Settlement Officer abused his discretion in sustaining the notice of federal tax lien filing.

Primary Holdings: 

• The IRS Settlement Officer did not abuse his discretion in sustaining the filing of the notice of tax lien. Specifically, I.R.C. § 6201(a)(4) applies because the Court of Appeals expressly intended to include the 2008 restitution order in its decision to vacate and remand Mr. Engle’s sentence.  Thus, the 2008 order was null and void but the new restitution order in May 2011 was effective.

Key Points of Law:

• I.R.C. § 6321 imposes a lien in favor of the United States on all property and property rights of a taxpayer liable for tax after a demand for the payment of the tax has been made and the taxpayer fails to pay. This lien arises when the assessment is made.  I.R.C. § 6322.  The IRS files a notice of federal tax lien to preserve priority and put other creditors on notice.  I.R.C. § 6323.  Under I.R.C. § 6320(a), the IRS must send written notice to the taxpayer of the filing of a notice of lien and of the taxpayer’s right to an administrative hearing on the matter.
• A taxpayer is strictly prohibited from challenging the existence or amount of an underlying liability that is related to an order of criminal restitution. Carpenter v. Comm’r, 152 T.C. 202, 219 (2019), aff’d, 788 App’x 187 (4th Cir. 2019).
• Where a determination by Appeals is predicated upon an error of law, that determination constitutes an abuse of discretion. Alessio Azzari, Inc. v. Comm’r, 136 T.C. 178, 191 (2011); Swanson v. Comm’r, 121 T.C. 111, 119 (2003).
• The IRS can make a restitution-based assessment only to the extent authorized by I.R.C. § 6201(a)(4)(A). That section provides that the IRS “shall assess and collect the amount of restitution under an order pursuant to section 3556 of title 18, United States Code, for failure to pay any tax imposed under this title [title 26] in the same manner as if such amount were such tax.”  The IRS’ collection authority under I.R.C. § 6201(a)(4) applies only to criminal restitution ordered after August 16, 2010.
• It is well settled that the mandate of a higher court is “controlling as to matters within its compass.” Sprague v. Ticonic Nat’l Bank, 307 U.S. 161, 168 (1939).  “[I]t is indisputable that a lower court generally is ‘bound to carry the mandate of the upper court into execution.’”  S. v. Bell, 5 F.3d 64, 66 (4^th Cir. 1993).  “[W]hen * * * [a higher] court remands for further proceedings, a district court must, except in rare circumstances, “implement both the letter and spirit of the . . . mandate, taking into account [our] opinion and the circumstances it embraces.’”  Id. at 66.

Insight:  The Engle decision stands for the proposition that criminal restitution orders may be difficult for taxpayers to challenge in CDP hearings and that such taxpayers should consider arguing more towards a collection alternative.

Larkin v. Comm’r, T.C. Memo. 2020-70 

May 28, 2020 | Gustafson, J. | Dkt. No. 6345-14

• Opinion

Short Summary:  Mr. and Mrs. Larkin were U.S. nonresident citizens for 2008 through 2010.  Mr. Larkin is an attorney, and Mrs. Larkin is a homemaker.  They owned interests in various entities and real properties in the United States and Europe and claimed deductions on Schedule A and Schedule E related to these activities.  They also claimed foreign tax credits.

The IRS examined the Larkins’ 2008 through 2010 returns and disallowed many of the Schedule A and Schedule E expenses, as well as the foreign tax credits.  Moreover, the IRS issued a notice of deficiency on these issues and also asserted the Larkins were liable for accuracy-related penalties and additions-to-tax for late filing of the returns.

At the Tax Court, the Larkins failed to properly address certain issues and failed to raise those issues in their post-trial briefings.

Key Issue:  Whether the Larkins are entitled to deductions for Schedule A and Schedule E expenses, self-employed health insurance deductions, foreign tax credits, and whether the Larkins are liable for additions-to-tax for late filings and accuracy-related penalties.

Primary Holdings:

• The Tax Court held that the Larkins: (1) failed to substantiate their Schedule A deductions beyond the amounts permitted by the IRS; (2) do not qualify as real estate professionals and are therefore precluded from deducting their Schedule E rental real estate losses after the passive activity loss limitations; (3) are not entitled to the additional self-employed health insurance deductions beyond the amounts permitted by the IRS; (4) are not entitled to a foreign tax credit carryover to 2009; and (5) are liable for the accuracy-related penalties for 2009 and 2010 and liable for additions-to-tax under I.R.C. § 6651(a)(1) for 2008 through 2010.

Key Points of Law:

• Any issue or argument not advanced in a post-trial brief is deemed abandoned. See Mendes v. Comm’r, 121 T.C. 308, 312-13 (2003); Nicklaus v. Comm’r, 117 T.C. 117, 120 n.4 (2001).  Thus, the Tax Court will generally only decide issues that the parties plead, address on brief, and do not concede.
• Under the Tax Court’s Rules of Practice and Procedure, a petition must contain clear and concise assignments of each and every error which the petitioner alleges to have been committed by the IRS in the determination of the deficiency. In addition, any issue not raised in the assignments of error shall be deemed conceded.  Rule 34(b)(4); Foley Mach. Co. v. Comm’r, 91 T.C. 434, 441 (1988).
• In certain circumstances, an issue not raised by the pleadings may be “tried by express or implied consent of the parties, * * * [and] treated in all respects as if they had been raised in the pleadings.” Rule 41(b)(1).  But when a party is not aware of an issue at trial, he cannot be held to have expressly or impliedly consented to the trial of that issue, as required for application of Rule 41(b).  See Markwardt v. Comm’r, 64 T.C. 989, 998 (1975). A taxpayer must carry his burden of proof with evidence offered at trial, to which his brief should refer. Rule 151(e)(3); Adeyemo v. Comm’r, T.C. Memo. 2014-1; D’Errico v. Comm’r, T.C. Memo. 2012-149. 
• I.R.C. § 6001 requires every person liable for any tax, or for the collection thereof, to keep records, and comply with the rules and regulations as the IRS may from time to time prescribe. Thus, a taxpayer is required to keep sufficient records to substantiate his gross income, deductions, credits, and other tax attributes.  See also Treas. Reg. § 1.6001-1(a).
• When a taxpayer adequately establishes that a deductible expense was paid or incurred but does not establish the precise amount, the Court may in some instances estimate the allowable deduction, bearing heavily against the taxpayer whose inexactitude is of his own making. Cohan v. Comm’r, 39 F.2d 50, 543-44 (2d Cir. 1930).  There must, however, be sufficient evidence in the record to provide a basis upon which an estimate may be made and to permit the Court to conclude that a deductible expense, rather than a nondeductible personal expense, was incurred in at least the amount allowed.  Vanicek v. Comm’r, 85 T.C. 731, 743 (1985).  The Tax Court must have some basis on which an estimate may be made.
• The Tax Court will not accept the testimony of a witness at face value to the extent it is implausible or not credible in view of the totality of the surrounding circumstances. Neonatology Assocs., P.A. v. Comm’r, 115 T.C. 43, 84 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).
• Whether to open the record to receive additional evidence is a matter within the discretion of the trial court. Zenith Radio Corp. v. Hazeltine Research, Inc., 401 U.S. 321, 331 (1971).  A motion to reopen the record will not be granted unless, among other requirements, the evidence relied on:  is not merely cumulative or impeaching, is material to the issues involved, and probably would change the outcome of the case.  Butler v. Comm’r, 114 T.C. at 287.  The Tax Court will also take into account other factors, such as “the character of the additional * * * [evidence] and the effect of granting the motion.”  See Purvis v. Comm’r, T.C. Memo. 2020-13.
• I.R.C. § 163(h)(3) provides that interest on a qualified residence is deductible by a non-corporate taxpayer. Qualified residence interest encompasses interest payments on two types of debt:  acquisition indebtedness and home equity indebtedness.  I.R.C. § 163(h)(3)(A).  “Acquisition indebtedness” generally means debt incurred in, or that results from the refinancing of debt incurred in, “acquiring, constructing, or substantially improving” a qualified residence.  I.R.C. § 163(h)(3)(B)(i).  “Home equity indebtedness” generally means indebtedness, other than acquisition indebtedness, that is secured by a qualified residence and that does not exceed the difference between the home’s fair market value and the amount of acquisition indebtedness.  I.R.C. § 163(h)(3)(C)(i).
• Personal interest is nondeductible unless it falls under one of the exceptions enumerated in I.R.C. § 163(h)(2), which allows for the deduction of “investment interest.” Investment interest is defined as interest which is paid or accrued on indebtedness properly allocable to property held for investment.  R.C. § 163(d)(3).  An individuals’ deduction for investment interest expenses cannot exceed his net investment income.  I.R.C. § 163(d)(1).
• I.R.C. § 164(a)(1) allows a deduction for “State and local, and foreign, real property taxes” paid within the taxable year; and I.R.C. § 164(a)(3) allows a deduction for “State and local, and foreign, income * * * taxes.”
• I.R.C. §§ 162 and 212 generally permit taxpayers to deduct ordinary and necessary expenses paid or incurred in carrying on a trade or business or for the production of income. However, in the case of an individual or entity listed in I.R.C. § 469(a)(2), I.R.C. § 469 disallows any current deduction for a passive activity loss.  I.R.C. § 469(a)(1), (b).  A passive activity loss is equal to the aggregate losses from all of the taxpayer’s passive activities minus the aggregate income from all passive activities.  I.R.C. § 469(d)(1).  Generally, a passive activity is any trade or business in which the taxpayer does not materially participate, see I.R.C. § 469(a)(1), (c)(1).  Rental activity (i.e., any activity where payments are principally for the use of tangible personal property are generally a per se passive activity.  See I.R.C. § 469(c)(2).
• An exception to the passive activity loss rules for rental activities exists if: (1) more than one-half of the personal services performed in trades or businesses by the taxpayer during the tax year is performed in real property trades or businesses in which she materially participates; and (2) the taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participates.  R.C. § 469(c)(7)(B).  A taxpayer materially participates in an activity “only if the taxpayer is involved in the operations of the activity on a basis which is—(A) regular, (B) continuous, and (C) substantial.”  I.R.C. § 469(h)(1).
• The regulations indicate that the extent of an individual’s participation in an activity may be established “by any reasonable means.” Reg. § 1.469-5T(f)(4).  Contemporaneous daily time reports, logs, or similar documents are not required, but a party may not rely on a post-event “ballpark guesstimate” or unverified, undocumented testimony.  See Moss v. Comm’r, 135 T.C. 365, 369 (2010); Lum v. Comm’r, T.C. Memo. 2012-103.
• A self-employed taxpayer may deduct health insurance costs paid for medical care for himself and his family, subject to special rules. The deduction may not exceed the “taxpayer’s earned income (within the meaning of section 401(c)) derived by the taxpayer from the trade or business with respect to which the plan providing the medical care coverage is established.  R.C. § 162(l).
• I.R.C. § 901(a) generally allows a taxpayer foreign tax credits for foreign income taxes paid, subject to the limitation imposed by I.R.C. § 904, which in turn limits the credit to the amount of U.S. tax on foreign income. A foreign tax credit is allowed only to the extent that the taxpayer can prove it was “paid or accrued” with respect to income from sources without the United States.  I.R.C. § 905(b)(1) and (2).  Even if a taxpayer proves payment of foreign tax, the credit for a particular year may be limited under I.R.C. § 904(a).  However, a taxpayer may carry back to the first preceding tax year or carry forward to any of the first 10 succeeding tax years any excess foreign tax paid or accrued for the year at issue.  I.R.C. § 904(c).
• A taxpayer claiming a foreign tax credit carryover must establish both the existence of the credit and the amount of any credit that remains (after application to previous years) to be carried over to the year at issue. Segel v. Comm’r, 89 T.C. 816, 842 (1987).
• Each tax year stands on its own and must be separately considered, and the IRS is not bound for any given year to allow a deduction permitted for a prior year. S. v. Skelly Oil Co., 394 U.S. 678, 684 (1969).
• I.R.C. § 6651(a)(1) imposes an addition to tax for late filing a return unless the taxpayer can show reasonable cause. Reasonable cause is not established simply due to the IRS having an open examination of a taxpayer’s prior year returns.  Denenburg v. U.S., 920 F.2d 301, 306 n.10 (5^th Cir. 1991).
• I.R.C. § 6664(b) provides that the accuracy-related penalty and fraud penalty only apply in cases where a return has been filed. If a taxpayer fails to file a return, the accuracy-related penalties do not apply.
• Negligence can be either the lack of due care or the failure to act reasonably under the circumstances. Neely v. Comm’r, 85 T.C. 934, 947 (1985).  Negligence “includes any failure to make a reasonable attempt to comply with * * * [the internal revenue laws],” sec. 6662(c), including any failure by the taxpayer to keep adequate books and records or to substantiate items properly, Treas. Reg. § 1.6662-3(b)(1).
• Under I.R.C. § 6751(b)(1), the IRS must show whether the supervisor in fact approved the penalty and therefore not “the propriety of the Commissioner’s administrative policy or procedure underlying his penalty determinations”, Raifman v. Comm’r, T.C. Memo. 2018-101, nor whether the supervisor “adequately contemplated [a] reasonable cause defense,” see id.
• Whether a taxpayer acted with reasonable cause and good faith is a facts-and-circumstances decision, and the most important factor is the extent of the taxpayer’s efforts to assess his proper tax liability. Reg. § 1.664-4(b)(1).  Also important is the taxpayer’s knowledge and experience.  Id.

Insight: The Larkin decision shows the dangers of not complying with the Tax Court’s Rules of Practice and Procedure.  Taxpayers should bear in mind that every assignment of error should be identified in the petition and should be addressed throughout the trial and post-trial briefing period.  In the event the taxpayer fails to do so, the Tax Court may consider the issues waived.

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